28 July 2016
Iran Unbound: A Land of Business Opportunity
Iran is on course to become one of the fastest growing economies in the MENA region following the removal of nuclear-related UN sanctions as of January 2016.
- Chart: Economic Size of Selected MENA Countries, 2015
- Table: EU Sanctions against Iran Lifted in Selected Sectors
- Chart: Iran Annual Inflation Rate
- Photo: High-rise buildings under construction
- Photo: A local supermarket selling soft drinks, including Coca-Cola, Sprite and Fanta
- Photo: Hong Kong clothing brands on sale in a Tehran retail outlet.
- Photo: An American clothing brand outlet in Tehran.
- Photo: A traditional bazaar in Tehran
- Photo: A modern shopping complex in Shiraz
- Photo: A steel factory in Isfahan
- Map: The International North-South Transport Corridor
After Saudi Arabia, Iran is the second-largest economy in the Middle East and North Africa (MENA) region, with an estimated nominal GDP of US$387.6 billion in 2015. Following the removal of major international sanctions in January 2016, Iran has been the subject of considerable interest from foreign investors seeking business opportunities in this upper-middle-income country. Overall, the country is characterised by a young and well-educated population, the majority of whom were born after the establishment of the Islamic Republic of Iran in 1979.
In light of the above, HKTDC Research recently undertook a field trip to Iran, setting out to assess the suitability of the country as an export destination for Hong Kong consumer products, such as electronics, garments and household goods, and to explore opportunities in Iran’s services market for Hong Kong services providers (HKSS) in a number of areas, including construction, project management, logistics, design and finance.
While the gradual restoration of access to the global financial and trading system is expected to enhance the investment climate in Iran, following the removal of nuclear-related UN or “secondary” sanctions in January 2016, HKTDC Research took into account lingering concerns over the so-called “primary” sanctions, which relate to trade with US individuals or companies. In addition, we also undertook a review of the country’s macroeconomic environment and local business practices in order to present an informed understanding of the local market conditions.
This report includes an overview of the business opportunities on offer, with the possible downside pertaining to any early market entry to Iran discussed in another article - Iran Unbound: Balancing Opportunities with Practical Business Risks.
The JCPOA Agreement: a Game Changer
From the time Iranian President Hassan Rouhani took office in August 2013, the government has made great strides towards reducing tensions between Iran and the West. Such tensions had led to a series of US, UN and EU sanctions, including a trade embargo, the freezing of overseas Iranian assets, and the prohibition of financial and bank dealings with Iran.
After some two years of negotiations, the Joint Comprehensive Plan of Action (JCPOA), a historical agreement between Iran and the P5+1 (the UN Security Council’s five permanent members plus Germany), was concluded in July 2015.
Under the terms of the JCPOA, major economic sanctions against Iran have been removed in exchange for Iran accepting international scrutiny of its nuclear programme. The JCPOA was implemented on 16 January 2016 (“Implementation Day”), heralding the removal of secondary sanctions, including the bulk of EU sanctions against Iran, along with the release of frozen overseas Iranian assets. While the US’s primary sanctions against Iran remain in place, the deal paves the way for a number of companies – primarily European - to re-enter Iran and invest in many of the country’s major economic sectors, such as transport, oil and gas, banking and finance.
In addition, an estimated US$100 billion in frozen assets, relating mostly to oil sales to Asian countries and held in escrow accounts during the sanction period, has been gradually released to Iran, providing the necessary capital for the country to fund its domestic development. Iran has been able to conclude many large procurement deals in the months following Implementation Day.
SWIFT Reconnection Lowers Transaction Costs
Iran’s international banking activity has severely curtailed since 2012, when almost all of the country’s banks were prohibited from using the Society for the Worldwide Interbank Financial Telecommunications (SWIFT) system, a global financial transaction protocol.
Following the implementation of the JCPOA, Iran access to the SWIFT system was restored in February 2016, allowing many Iranian banks to resume cross-border transactions. This has inevitably lowered transaction costs for Iranian companies in light of the intermediary costs that would otherwise be paid to Dubai middle-men. It also eases the country’s general trading environment.
So far, some 30 Iranian banks, including Bank Melli and Bank Mellat, have re-joined SWIFT. As a sign of the further normalisation of banking ties, the Industrial and Commercial Bank of China (ICBC) has applied to open branches in Iran. Italy’s Monte Paschi Di Siena Bank is also reported to have provided bank guarantees and letters of credit services to several Iranian banks following the lifting of sanctions. Nonetheless, many major international banks have been hesitant about resuming business ties with Iran, particularly in view of the outstanding primary sanctions.
Restored Macroeconomic Stability Helps Economic Prospects
In light of the impact of international sanctions on Iran’s economy – including heavy borrowing from the Central Bank of Iran (CBI) to fund widening government deficits – the Rouhani government, which took power in 2013, has taken major measures aimed at tackling soaring inflation and unemployment.
In 2013, following the expansion of sanctions imposed by the US and the EU against the country’s energy and banking sectors, the country’s level of inflation hit a peak of 40%. In order to stabilise this, the Rouhani government introduced a number of measures, including major subsidy reforms and the replacement of cash hand-outs with non-cash benefits. As a result, consumer price inflation over the past Iranian calendar year eased to 11.9% from 15.6% year-on-year. According to the CBI, this declining trend is anticipated to continue, with inflation expected to edge down to single digits by March 2017.
In order to tackle the country’s high unemployment rate, which stood at 11.8% in the first quarter of 2016, the Rouhani administration has proposed ambitious economic reforms through a process of privatisation.
Iran has a large public sector. This exerts substantial control over the economy through state-owned enterprises (SOEs) or semi-private entities, such as foundations, pension funds and companies linked to the Islamic Revolutionary Guard Corps (IRGC). In 2016, it was announced that Iran Air, the government-owned Iranian flag carrier, and the country’s car industry, were to be privatised, along with 201 companies on the 2016 Divesting Lists published by the Iranian Privatisation Organisation. It is believed that this will help improve efficiency by releasing resources tied up in inactive projects and used to fund budgetary shortfalls, ultimately giving an extra push to the privatisation agenda.
Post-Sanctions Development Calls For Foreign Investment
Following years of limited access to external capital, the Iranian government is now keen to attract foreign direct investment (FDI) across a number of sectors, particularly those where new equipment and technology are in high demand.
In the short-to-medium term, the focus of the Iranian economy is expected to be on bridging the funding gap related to major investment projects. In particular, the Iranian government aims to attract up to US$50 billion annually in order to meet an ambitious 8% GDP growth target, as set out in in the sixth Five-year Development Plan for the 2016-2021 period.
Over the longer term, it is estimated that Iran will create investment opportunities of US$1.5 trillion between 2016 and 2025 for local and international investors.
In line with Vision 2025, the Iranian government identifies a number of core industries that the country will focus on developing. These include petrochemical products, metals and minerals, energy, food, pharmaceuticals, industrial machinery and equipment, home appliances, textiles and apparel, and transport.
More specifically, several strategic growth objectives have been outlined in relation to this long-term development plan. These include productivity enhancement through the adoption of advanced technologies; a focus on innovation-driven manufacturing; economic diversification from oil and gas to high value-adding downstream segments; and the establishment of joint-venture manufacturing plants to lower export costs.
It has also been reported that the Iranian government plans to incrementally increase its net investment in manufacturing. This emphasis on manufacturing growth presents ample opportunities for foreign companies to participate in Iran’s ongoing transformation, whether through investing in the manufacturing of petrochemical products, steel, automobiles and consumer goods, or by providing services related to technology, manufacturing process enhancement and the financial sectors.
Opportunities Not Confined to Capital-Intensive Sectors
Home to the world’s second- and fourth-largest reserves of natural gas and crude oil respectively, Iran’s economy is more diversified than most other oil-rich countries in the region, with oil export revenues accounting for only about 30% of the government budget. In the 2014/15 fiscal year, which ended 20 March 2015, the oil sector contributed 15.3% of Iran’s gross national product, followed by the restaurant and hotel trade (15.0%), real estate, specialised and professional services (15.0%), manufacturing (11.8%) and agriculture (9.3%).
Although the oil and gas and other large-scale, capital-intensive sectors such as transport and infrastructure are expected to be the most immediate beneficiaries following the lifting of sanctions, the country is also fast attracting the attention of companies across a number of non-oil industries.
It is worth noting that Iran has maintained a reasonably large domestic manufacturing industry despite the many years of sanctions. This means Iran is quite different to many other emerging markets, where the installation of entirely new production plants is often required, entailing large sums of initial capital. FDI investors in Iran instead have the option of upgrading existing facilities, thus diminishing initial capital requirements. Furthermore, the government is committed to providing a host of incentives to FDI investors, many of which are sector-specific.
Consumer Goods Opportunities
With a population of nearly 80 million and more than 60% of its citizens aged 30 or under, Iran is also one of the largest retail markets in MENA with strong growth potential for imported goods. Throughout the sanctions period, Iran’s large middle class maintained a strong preference for foreign products, with this strong demand met by imports through Dubai and Turkey. This preference is expected to further strengthen in the post-UN sanctions era, as trade and banking normalisation eases related business activity.
During its recent field trip to Iran, HKTDC Research was informed that western companies – including several soft drinks companies – had already entered into domestic licensing deals, under which their products could be manufactured within Iran. At present, Iranian traders and middlemen source products from many international brands via Dubai and Turkey, before re-exporting them to Iran. It was also reported that cargo carriers regularly ship goods to Iran from the free trade zones in Dubai, such as the Jebel Ali Port. Iranian free trade zones, such as Kish Island and Qeshm Island, are locations where international products, many of which are fast-moving consumer goods destined for mass markets, are shipped back to the mainland of Iran.
Prior to the lifting of UN sanctions, most Iranian customers had to make do with “international products” that were of an inferior quality, many of them counterfeit. With sanctions now lifted, Iran’s retail landscape is likely to experience rapid changes in response to the pent-up demand for authentic, high-quality imported goods, including electronics, telecom products and parts, watches and clocks, jewellery, clothing and other consumer products.
As the US has retained its primary sanctions, banning US citizens, companies and financial institutions from doing business with Iran, all transactions made between Iran and the rest of the world are primarily conducted in currencies other than US dollars, notably Euros or RMB. As such, Hong Kong companies which can settle payments in RMB have a distinct advantage.
In addition, as the consumer market further opens up to international companies, there will be an increasing demand for modern retail outlets in order to serve the needs of a young, tech-savvy population, many of whom increasingly prefer large shopping complexes to the traditional bazaars. This may fuel the further development of the construction sector, with new shopping facilities now being built to meet this surging demand.
An Emerging Trade Hub along the Belt and Road
Throughout the sanctions period, China maintained a business relationship with Iran. China has been Iran’s largest trading partner for six consecutive years and there is already a strong foundation in place for both sides to strengthen their economic relationship in the post-sanctions era.
Following the removal of sanctions, China’s President Xi Jinping visited Iran in January 2016. During the visit, the two countries entered into an agreement on a 25-year comprehensive strategic partnership that will deepen co-operation in a number of areas, including communication, railways, ports, energy, trade and services. This will entail a tenfold boost in bilateral trade, taking it to more than US$600 billion over the next decade.
One of the major countries along the China-Central Asia-West Asia (CCAWA) Economic Corridor, as mapped out under China’s Belt and Road Initiative (BRI), Iran is expected to benefit from the BRI’s focus on infrastructure development and technology collaboration. This should stimulate demand across a number of sectors, including rail and road transport, energy, telecommunications and real estate.
At the time of writing, the China National Transport Equipment & Engineering Co Ltd is reportedly close to finalising an agreement on a US$3 billion high-speed rail project connecting Tehran with Mashhad. There are also plans for China and Iran to establish a 3,000-4,000 hectares joint industrial estate in Jask Port in southern Iran. This will focus on petrochemical projects, refinery, and steel and aluminum production.
A Potential Gateway to Regional Markets
Located in Southern Asia and bordering the Persian Gulf, the Caspian Sea and the Gulf of Oman, Iran prides itself on being a gateway to a regional market of more than 400 million people, spanning Afghanistan, Iraq, Turkey, Russia and the Central Asia countries. Following the lifting of sanctions, the subsequent easier movement of goods will result in significant trade opportunities, helping Iran to emerge as a trade and logistics hub in the region.
As indicated above, Iran is also a major country along the CCAWA Economic Corridor, an important element in China’s BRI. While the BRI is intended to enhance land and sea connectivity with countries along its key routes, the International North-South Transport Corridor (INSTC), established in 2000, aims to connect the Indian Ocean and Persian Gulf to the Caspian Sea via Iran, and onward to northern Europe via St. Petersburg in Russia. As a multi-modal transport corridor, INSTC will make Iran a key link in connecting the 14 member states, including India and Russia.
Moreover, in May 2016 India announced plans to invest US$200 million in developing two terminals and five berths at the Iranian port of Chabahar, with an additional US$300 million available for related infrastructure development. The Iranian government is reportedly now seeking investment from other countries to help fully develop the area.
In addition to construction projects, Asian manufacturers seeking to export to Europe might also benefit from Iran’s geographic proximity to the region, should they choose to establish a production base in the country. Iran boasts dozens of free zones and special economic zones where foreign investors can build new production plants while benefiting from a range of investment incentives.
 According to the World Bank, Iran is classified as an upper-middle-income economy, with a GNI per capita between US$4,126 and US$12,735.
 The Iranian calendar year of 1394 ended on 19 March 2016.
 The member states in the International North-South Transport Corridor include: Iran, India, Russia, Belarus, Kazakhstan, Tajikistan, Oman, Armenia, Azerbaijan, Syria, Ukraine, Turkey, Kyrgyzstan and Bulgaria (observer).